Carbon-Neutrality Tomorrow and Energy Regulation Today

Like many developed countries, Canada has committed to significantly reducing greenhouse gas emissions in the coming decades. The federal government has committed to achieving net-zero emissions by 2050: see the Canadian Net-Zero Emissions Accountability Act, SC 2021, c 22. Even the provinces that are often at loggerheads with the federal government about climate policy acknowledge the need to decarbonize the Canadian economy or reach carbon neutrality: Ontario has committed to a 30% reduction in emissions relative to 2005 levels by the end of this decade; and Alberta’s goal is to achieve a carbon neutral economy by 2050.

Notwithstanding my reservations about the difficulty of defining “policy” for administrative law purposes, I think reducing carbon emissions must satisfy the definition: it is a commitment to a course of action that has a material effect on actions taken. Quite what ‘material effect’ will mean in any given context, however, is a multi-million dollar question. It has been posed and answered in different ways in several recent controversies.

Last December, the Ontario Energy Board made a rate-setting decision addressing (amongst other things) the costs of connecting new houses to the natural gas network. The Board has, of course, extensive powers in setting rates that are “just and reasonable”, fair both to utility companies and consumers.

Here, Enbridge had made an application to the Board to set a cost-of-service rate. In determining whether to approve the application or not, the Board had to decide whether the costs Enbridge proposed to incur were reasonable and based on prudent infrastructure investments, and whether Enbridge’s proposed return was fair.

One of the problems the Board faced was that new houses are being connected to the natural gas network but, if one takes the commitment to reducing greenhouse gas emissions seriously, it is inconceivable that these houses will be entirely heated by natural gas come 2050. Yet Enbridge insisted on depreciating the cost of hooking up new houses over a 40-year period. The Board explained the problem as follows:

Enbridge Gas’s costs to connect new customers are largely upfront costs, related to the initial work to physically connect the customer to the gas system. Revenues, on the other hand, are expected to be collected over the full revenue horizon through rates. If customers do not remain Enbridge Gas customers for the full revenue horizon, as a result of moving away from natural gas to electricity, there would be a revenue shortfall that would either be recovered from remaining customers or borne by the utility’s shareholders. In other words, there is a risk of stranded asset costs which have not been fully paid for in rates (at p. 26).

This caused the Board significant concerns. They concluded that Enbridge had not demonstrated that its proposed capital spending plan was prudent.

An essential component of prudent investment is the identification, management, and mitigation of risk. This includes the risk arising from the energy transition, the very risk that Enbridge Gas relies upon to justify an increase in its deemed equity thickness, which, if approved, would increase Enbridge Gas’s return on its investment.

The energy transition is underway, underpinned by the totality of current government policy. The reality of the energy transition provides context for the OEB to understand the risks, mitigation of those risks, and potential cost consequences posed by Enbridge Gas’s application. The risk that arises from the energy transition results from gas customers leaving the gas system as they transition to electricity to meet energy needs previously met by natural gas. This departure gives rise to assets that are not fully depreciated but are no longer used and useful. This results in stranded asset costs that Enbridge Gas would seek to recover from the remaining gas customers. This in turn would increase rates for those gas customers, leading more customers to leave the gas system, potentially leading to a continuing financial decline for the utility, often referred to as the utility death spiral.

In the face of the energy transition, Enbridge Gas bears the onus to demonstrate that its proposed capital spending plan reflected in its Asset Management Plan is prudent having accounted appropriately for the risk arising from the energy transition.

The record is clear that Enbridge Gas has failed to do so.  Enbridge Gas has taken the position that there is no stranded asset risk for the purpose of setting rates for 2024.  This is not logical (at pp. 20-21).

Ultimately, “[w]hen looked at through the 40-year lens, what Enbridge Gas proposes looks very much like business as usual and it is not sustainable”. The majority of the Board proposed a zero-year revenue horizon instead (the dissenting member favouring a 20-year horizon). The logic of the Board’s position is that it is necessary to give property developers the proper incentives:

When a developer is faced with the full cost of including gas service in a development, that developer will be fully incented to choose the most cost effective, energy efficient choice in a manner that not only achieves efficiency in the cost of housing in a competitive market and lowers the operating cost of that housing, but also maximizes the contribution to achieving government decarbonization policy goals. It also eliminates the split incentive problem (at p. 41).

See further Nigel Bankes.

As Ian Mondrow explains, this is a significant issue for the utility:

As a regulated utility, EGI earns its profit on the basis of the equity invested in its asset base. Historically EGI finances the capital cost of new gas connections and recovers those costs from gas customers over 40 years. During that period, the unrecovered new connection costs are added to EGI’s asset base, on which it earns a return on investment. That’s about one billion dollars of asset base and associated return on investment over five years of new customer connections. The new OEB policy would mean that, starting in 2025, EGI’s rate of asset and earnings (i.e. business) growth would drop off significantly. If one were to assume that the risk of the future stranding of such investment rests with gas customers rather than EGI’s shareholder, one can certainly understand why this impact on business growth would be a significant concern for EGI.

The utility has responded with a motion to reconsider and an appeal (described here by Gordon Kaiser KC) that have the potential for far-reaching consequences on regulatory practice and policy in Canada: one of Enbridge’s propositions is that the Board’s decision is unlawful because it runs counter to the policies of the Government of Ontario. A decision in favour of Enbridge on this point would be highly consequential, especially given the difficulty of defining “policy” for administrative law purposes.

The response of the Ontario government was swift: it proposed legislation to override the Board’s decision and that bill is currently working its way through the parliamentary process.

There has been litigation about the energy transition in Quebec. In Hydro-Québec c. Régie de l’Énergie, 2024 QCCS 718 (leave to appeal granted 2024 QCCA 468), the Régie de l’énergie had, in a reconsideration proceeding, overturned its original decision. The original decision (Régie 1) allowed by majority Hydro-Québec’s application to treat payments made to its partner in a bi-energy project as costs for rate-setting purposes. On reconsideration (Régie 2), the Régie came to a different view, on the basis of its interpretation of the Act respecting the Régie de l’énergie, CQLR c R-6.01. But on judicial review, Collier J quashed the reconsideration decision, on the basis that Régie 2 simply disagreed with the analysis of Régie 1, which was not an available ground for reconsidering the original decision.

Again, government policy was a central part of the discussion, for Hydro-Québec had engaged in the bi-energy project in order to contribute to the province’s goals of reducing emissions by 37.5% under their 1990 levels before 2030. Accordingly, Régie 1 had given a large and liberal interpretation to the terms “required revenue” (revenus requis) and “necessary” “expenditure” (dépenses nécessaires) (at para. 17), recognizing as a general principle that the cost of this sort of project could be considered for the purposes of rate setting (at para. 21).

But the power to reconsider decisions is statutory and it is strictly limited. Régie 2 could only reconsider this interpretation if there were a serious and fundamental flaw, an “erreur si grossière qu’elle invalide la décision ou en fait une décision qui, à sa lecture même, est invalide (un qualificatif fort), une erreur, en somme, dont « la gravité, l’évidence et le caractère déterminant » sautent aux yeux” (Corbi c. Ville de Montréal, 2021 QCCA 1899, at para. 14). For Collier J, the Régie 2 decision revealed only a difference of opinion on interpretive issues, which is never enough to justify reconsideration (at para. 32). Even if he accepted that the precise scope of the Régie 1 decision was difficult to determine (at para. 56), this did not justify recourse to the power of reconsideration.

In any event, Collier J concluded despite these misgivings that the Régie 1 decision was reasonable:

La décision Régie-1 ne compte pas moins de 708 paragraphes sur 197 pages.  Elle est divisée en 14 parties, dont la dernière comprend l’opinion dissidente du régisseur François Émond.  Avant d’arriver à ses conclusions, la formation majoritaire examine la demande des distributeurs, la nature du projet biénergie, les dispositions de la Loi sur la Régie de l’énergie, les pouvoirs de la Régie, les règles d’interprétation statutaire, et l’impact tarifaire du principe général demandé.  Les motifs de la formation majoritaire et du régisseur dissident sont logiques et explicites, avec de multiples références aux faits et aux principes juridiques.  Incontestablement, la décision Régie-1 est intelligible et justifiée quant à ses conclusions.

En outre, les conclusions de la Régie-1 constituent des « issues possibles acceptables pouvant se justifier au regard des faits et du droit »[42].  Il en est ainsi de la conclusion selon laquelle une interprétation moderne et dynamique des articles 49 à 52 LRÉ permet à la Régie – dans l’exercice de son pouvoir discrétionnaire –, de conclure que la Contribution GES constitue des « revenus requis » aux fins tarifaires.  C’est également le cas en ce qui concerne la conclusion selon laquelle le principe général demandé par Hydro-Québec et Énergir ne prive pas la Régie de tout pouvoir décisionnel au moment de fixer les tarifs (at paras. 59-60).

Enbridge’s motion for reconsideration and appeal are pending, and the Quebec Court of Appeal will soon hear the appeal in the Régie 1/Régie 2 case, so there will be future developments in this fast-moving area.

In their posts, Nigel Bankes and Gordon Kaiser discuss regulatory developments in other provinces. These issues will keep coming up and, no doubt, there will be significant further litigation that will generate important insights about regulatory law and policy, as well as principles of administrative law.

This content has been updated on May 2, 2024 at 13:09.